Overends, determined to show the Bank that it was not omnipotent, allowed their account at the Bank of England to run largely into credit, and one day suddenly demanded three millions in cash. Their ruse failed. Indeed it was as stupid as the resolution which goaded them into making the effort; for, of course, were the Bank to refuse to assist the bill brokers during a panic, it would only be adding fuel to the flames and increasing its own difficulties. Small wonder then that so absurd a decree created intense irritation, for, upon examination, it is evident that the Bank of England is as dependent upon the bankers' balances in a time of panic as are the bill brokers upon the institution which holds them. Then what folly to advertise such a decision!
Naturally, the Bank is not pleased at the thought that it must help its rivals over the stile, but the peculiarities of our banking system compel it to, whether it like the task or not. Therefore, it was an error of judgment on the part of the directors of the Bank to pose as the champions of the banking community, and to declare that the bill brokers must, in future, accumulate reserves of their own, when they knew quite well that the nature of their business utterly precluded such an attempt.
During a panic the Bank of England can only save itself by advancing freely against certain securities and good bills. The credit so created, however, swells the bankers' balances in its own books, and consequently the amount standing to the credit of the bankers increases appreciably. But, at such a moment, the bankers call in large sums from the bill brokers, and, unless the brokers can obtain advances from the Bank of England against good bills and gilt-edged securities, they will be unable to satisfy the demands of Lombard Street. By declining to advance to the bill brokers, the Bank, in reality, would be refusing credit to Lombard Street (bankers' balances); and, as the Bank itself could not live were Lombard Street to withdraw its balances at so critical a time, it follows that it must lend to the bill brokers in order to enable them to repay the bankers. It simply dare not refuse to assist them, for, if it did, the banks might decline to support the Bank which left them in the lurch just at the height of the storm. The bill brokers (the outside market) come within our present credit system, and if, when a state of panic prevails, they were left to their fate, in every probability the system of which they form a part would collapse with them. The brokers may not be essential to the system, but it is always dangerous to "swop horses whilst crossing a stream."
In 1865 Overend, Gurney & Co. converted their business into a joint stock company for the same reason that some private firms adopt the procedure—because their profits were decreasing—though this was not known until after the crash of 1866. During the panic of 1857 the Bank of England made large advances to Overends; but when, early in May, 1866, the firm again applied to the Bank for assistance, the request was refused. It has been suggested that the Bank's decision was prompted by malevolence, but at so crucial a moment the directors of the Bank would have hesitated to make a rod for their own backs, and, had they believed in the genuineness of Overends' application, they would have gladly granted the accommodation in order to spare themselves the panic which they knew must follow their refusal to assist a firm with liabilities of over £19,000,000. Moreover, subsequent events confirmed the judgment of the directors of the Bank of England.
When the partners of Overend, Gurney & Co. discovered that their books were full of possible bad debts, they promptly converted the firm into a company, guaranteed the book debts, and appointed directors. Shortly afterwards it was noticed that the Gurneys were realising their property, and suspicion was at once aroused, for it was naturally assumed that they had incurred heavy losses. When, therefore, the company appealed to the Bank the next year, the directors were sceptical, for though Overends still retained the entire confidence of their country customers, there undoubtedly existed a feeling of distrust in the City, and the directors of the Bank of England shared in the opinion there prevailing.
When the rash speculations of the partners were disclosed the public was loud in its abuse, and nothing short of a prosecution would satisfy it; and when, early in January, 1869, the directors of Overends were committed for trial on the gravest of charges, the crowd manifested its delight. But the comedy followed. The trial took place at the end of the year, by which time public opinion had completely veered round, and when it became known that the accused were acquitted, this same crowd cheered lustily. Small wonder that a Government, which must be well aware of the vagaries of crowds, should hesitate to conduct a public prosecution.
The panic of 1866, though the suspension of the Bank Act immediately brought relief, dealt a fearful blow to credit, and the country recovered from the shock with painful slowness. Foreigners, alarmed by the disorganisation of the London money market, began to withdraw their capital, and the Bank, in order to check this drain of gold outwards, was compelled to keep its discount rate at ten per cent. for three weary months.
By the middle of 1867 the Bank rate was at two per cent.; but even the company promoter had not the audacity to show himself, so depressed was the public spirit by the disasters of the previous year. The great railway companies, too, began to find themselves in financial straits, and their credit was so bad that they could only raise money on debenture stocks at high rates of interest, for the public then looked upon their ordinary shares as distinctly speculative holdings. As the railway directors neglected to borrow with the option of redemption at certain figures at a future date, it followed that, when their credit greatly improved at a later period, the companies were saddled with a huge drain in the shape of high interest on their debenture issues, whereas, had their directors exercised ordinary prudence, they would now be paying very much less upon their prior stocks, and consequently the dividends on their ordinary shares would be proportionately greater. Evidently, then, the interests of the shareholders were sacrificed to the holders of the debenture and preferred stocks.
As the prior stocks absorb so large a share of the profits, and, moreover, as the amount so absorbed is practically always the same, whereas the revenue is variable, it follows that the distributions on the ordinary shares fluctuate considerably. This fact, of course, has not escaped speculators, who work out the ratio of ordinary share capital to total capital; and the smaller the ratio the more inconstant will be the dividends, and the greater the movement in prices. Investors know that, should the trade of the country be improving rapidly, a certain railway will earn more; and if its share capital ratio be small, then the increase in revenue will largely swell the ordinary dividends thereupon—so they speculate for a rise.